One Way to Get Into Trouble Administering Your Company’s Retirement Plan

by Eric Henon, President, EACH Enterprise

Summary

This article provides guidance for administrators of 401(k), 403(b), and 457 retirement plans on participant requests to reverse a cash distribution of plan assets in good order, even if the participant misunderstood the tax implications. The article outlines the legal, financial, operational, and fiduciary risks involved, and emphasizes the importance of maintaining plan integrity and compliance.

How the Story Starts

On a rare occasion, a plan participant may approach the service provider of their 401(k), 403(b), or 457 retirement plan after requesting a cash distribution of plan assets with all required documentation, asking that the good order transaction be reversed, arguing that they did not realize that income tax would be due and withheld at the time of distribution.  However, a plan sponsor would be ill-advised to authorize such a request that would expose them to fiduciary risk.

Tax Withholding Is Irrevocable

Once a distribution is processed, federal income taxes are withheld and sent to the IRS immediately. These funds are no longer under the plan’s control. Reversing the transaction would require a reimbursement from the IRS—something neither the plan sponsor nor the service provider is authorized or equipped to request. Participants must resolve any tax overpayment through their personal tax return.

Custodial and Banking Barriers

After distribution, funds are typically deposited into a participant’s personal account. They may be spent, moved, or invested. Even if a participant agrees to return the money, retrieving and reprocessing it is complex and unreliable. This introduces unnecessary risk to the plan and its fiduciaries.

Operational Complexity and Cost

Reversals are not simple. They require recalculating taxes, issuing corrected tax forms (e.g., 1099-R), updating plan records, and coordinating across multiple departments. These tasks are time-consuming and costly, diverting resources from core operations and potentially increasing fees for all participants.

Audit and Regulatory Risk

Reversing a distribution can raise red flags during audits by the Department of Labor (DOL) or independent auditors. It may be viewed as a prohibited transaction or operational failure, exposing the plan to penalties and reputational damage.

Fiduciary Risk and Precedent

Making exceptions based on participant misunderstandings sets a dangerous precedent. It opens the door to future claims and undermines the consistent application of plan rules. Fiduciaries must act in the best interest of all participants—not just one.

Disclosure Obligations Are Met

Participants receive clear documentation about tax implications, including Summary Plan Descriptions, distribution forms, and IRS Form 402(f) Special Tax Notice. The plan’s responsibility is to provide this information—not to ensure it is read or understood.

Conclusion

While participant confusion is unfortunate, reversing a legally executed distribution in good order is not the answer. The risks far outweigh the benefits. Upholding the integrity of plan operations protects everyone—sponsors, fiduciaries, and participants alike.

Write to Eric Henon at ehenon@eachenterprise.com

THE BEST 401(k) PLAN THAT MONEY CAN BUY

1. Plan design – money purchase or cash balance plan, combined with a 401(k) plan, and an NQDC plan for highly compensated employees and those earning more than $145,000 who are constrained by legislation. Default options that will lead participants to success (especially long-time employees who entered the plan late, or did not save enough for retirement for no fault of their own).
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6. Professional administration. If the plan sponsor does not employ a dedicated retirement plan specialist with extensive experience running retirement plans, retain the services of a professional administrator who accepts ERISA 3(16) fiduciary, and maybe even 402(a) fiduciary status. Why not? These services can be obtained through a Pooled Plan Provider in the context of a PEP plan or in a single employer plan.
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Yes, the solution could be the most expensive in the market. When the plan sponsor covers all the fees, considering only cost does not act in the participants' best interest. For sponsors so fortunate to operate in a sector or market that requires the best talent that money can buy, indeed, the retirement plan also should be the best that money can buy, and it could be the most expensive option available. Why wouldn’t you get the best for your employees if you can afford it?

If your employees merit it and you can afford it, buying them a Rolex® time piece at retirement is a great choice.

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